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Senate Republicans Block Debate on Financial Reform Bill

by • April 26, 2010

Senate Minority Leader Mitch McConnell

Democrats failed to get the cloture vote, on Monday, which is necessary to proceed debate on a financial reform bill that would put tougher restrictions on Wall Street. The BBC reports that the bill would:

…tackle financial institutions that are “too big to fail”, putting in place a framework that would mean taxpayers do not fund any future bailouts.

Among the bill’s proposals are changes to the derivatives market and tougher legislation to protect consumers.

The bill also aims to crack-down on a complex financial tool called derivatives. The trading of derivatives would have to be done on an open market, and some firms would be unable to continue their current operations.

If the Democrats can brand their opponents as the sort of Washington politicians who would line the pockets of their Wall Street friends rather than vote for a measure to protect the American people, it might or might not turn the polls around, but it might save a few seats. And it gives them that most important thing in politics – a story to tell, with heroes, villains and dragons to slay.

Republicans reject a few of the proposals in the bill and would like to change it in their favor. Viser writes:

One of the main targets of Republican opposition has been a $50 billion fund that would be used to wind down failing institutions. The fund would be comprised of fees from large financial institutions, but Republican opponents have said that it could still allow for bailouts of large firms…

Republicans also oppose the so-called Volcker rule, named for former Federal Reserve chairman Paul Volcker. The rule would put new investment restrictions on large institutions, including preventing them from owning private equity funds.

Based on the things they are opposing, it’s an easy sell to voters that Republicans are taking their orders from Wall Street. Hernando de Soto, considered by David Frum (a conservative) to be “one of our greatest free-market thinkers,” outlines the ideal regulations for derivatives which happen to be included in the bill:

– All documents and the assets and transactions they represent or are derived from must be recorded in publicly accessible registries. It is only by recording and continually updating such factual knowledge that we can detect the kind of overly creative financial and contractual instruments that plunged us into this recession.

– The law has to take into account the â€œexternalitiesâ€ or side effects of all financial transactions according to the legal principle of erga omnes (â€œtoward allâ€), which was originally developed to protect third parties from the negative consequences of secret deals carried out by aristocracies accountable to no one but themselves.

– Every financial deal must be firmly tethered to the real performance of the asset from which it originated. By aligning debts to assets, we can create simple and understandable benchmarks for quickly detecting whether a financial transaction has been created to help production or to bet on the performance of distant â€œunderlying assets.â€

– Governments should never forget that production always takes priority over finance. As Adam Smith and Karl Marx both recognized, finance supports wealth creation, but in itself creates no value.

– Governments can encourage assets to be leveraged, transformed, combined, recombined and repackaged into any number of tranches, provided the process intends to improve the value of the original asset. This has been the rule for awarding property since the beginning of time.

– Governments can no longer tolerate the use of opaque and confusing language in drafting financial instruments. Clarity and precision are indispensable for the creation of credit and capital through paper. Western politicians must not forget what their greatest thinkers have been saying for centuries: All obligations and commitments that stick are derived from words recorded on paper with great precision.

Above all, governments should stop clinging to the hope that the existing market will eventually sort things out. â€œLet the market do its workâ€ has come to mean, â€œlet the shadow economy do its work.â€ But modern markets only work if the paper is reliable.

Moreover, the consumer protection agency to be created by the bill will be necessary to stem predatory lending. This kind of lending ultimately led to unqualified people or businesses getting loans which ended up being a cause of the recent financial crisis.